Vanguard Files for Active ETFs, No Immediate Plans: Spokesman

By Brendan Conway

Vanguard Group this morning laid the groundwork for exchange-traded fund versions of dozens of popular actively managed mutual funds, although a spokesman tells Barrons.com there are no immediate plans to offer the ETFs.

The March 7. filing with regulators requests permission to build ETF versions of Vanguard Wellington (VWELX), Vanguard Explorer (VEXPX), Vanguard Wellesley Income Fund (VWINX), and more than half a dozen muni-bond fund families, among others. Just because a fund is included in the filing doesn’t necessarily mean an ETF version will be built, the spokesman stressed.

The company manages about $860 billion in active mutual funds in addition to its well-known passive index funds and ETFs. See the complete list here.

Vanguard getting active in ETFs?

The spokesman told us Friday morning by email that the idea, first spotted by Daniel P. Wiener of the Independent Adviser for Vanguard Investors, would apply to new actively managed stock and bond funds as well as existing ones.

Here’s what the spokesman said when asked about the inclusion of Vanguard Wellington and other well-known mutual funds:

Vanguard will not offer ETF shares of a fund unless its adviser reasonably believes that the daily disclosure of portfolio holdings would not have an adverse effect on the portfolio strategy and its execution. This determination will be made based on the markets and securities in which the fund invests, as well as the fund’s investment style, strategy, and policy.

Investors each day can see the stocks held by ETFs like SPDR S&P 500 ETF (SPY) or iShares Core S&P 500 ETF (IVV), and that transparency is one of the most oft-cited reasons for mutual-fund firms’ ETF-building hesitancy. (Of course, fund makers are also probably wary of undercutting their existing businesses.)

The trend of big fund companies laying groundwork for and launching actively managed ETFs lately is heating up. Earlier this year, State StreetFidelity Investments paired with MFS Investment Management to launch a trio of the funds, although investor uptake has been limited. Other big-name asset managers who’ve built actively managed ETFs or begun preparing include Pimco, Eaton Vance, Franklin Resources, and J.P. Morgan Chase.

Nearly a year ago, speaking on the Barron’s ETF Roundtable, Vanguard ETF strategist Joel Dickson suggested the company was in no rush to build actively managed ETFs. He also underscored risks. For instance, how would a large-scale active ETF deal with an influx of too much money? It doesn’t have the same options as a conventional mutual fund:

[Dickson:] Active ETFs are interesting, and certainly we could do something. Or we might not. I see active ETFs not so much as an investment play, but as a distribution play. You’ve got old-line mutual-fund cost structures that emerged from traditional commission-based selling platforms. But there has been a huge shift toward fee-based platforms. From a distribution standpoint, there is a lot of runway for active ETFs.

[Barron's:] Could there be an actively managed Vanguard ETF?

[Dickson:] The biggest hurdle for us has been, and continues to be, the condition of portfolio-holdings transparency. But more broadly, what’s the endgame with an active exchange-traded fund? Let’s say you are successful. You need a high-capacity product to even think about doing this. At Vanguard and many other shops, when capacity limits have been reached, you close the fund. What does it mean to close an ETF? We’ve seen what happens when you cut off share creation — you get a premium and a lot of volatility. That is not well understood by investors. They don’t understand how the arbitrage mechanism breaks down. [For more on that, see "The Biggest Hurdle,".] I think that’s an interesting question in actively managed ETFs. How are shareholders served if you are successful — too successful — with the product?

Correction 10:15 a.m.: The eigthth paragraph of the original version of this blog mistakenly said Fidelity Investments paired with MFS Investment management for actively managed ETFs. It was State Street, not Fidelity.

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